“... Every day for us something new… Open mind for a different view… ’
Metallica, Nothing Else Matters
Last week, we discussed the UK and GBP in the context of domestic and global factors as economic data and the fiscal implications of the Autumn Statement brought the UK into central focus. We argued that the growth dynamic will likely come increasingly into focus, exacerbated by the fact that “at some point we expect house prices to feed into the negative demand dynamic as property price declines weigh on sentiment…especially as it is likely that much of the past BoE policy tightening is yet to be felt in the property sector (a major protagonist in the ‘long and variable lags’ premise of monetary tightening)”.
Furthermore, from a fiscal tightening perspective, we questioned the huge fiscal pivot from the UK Government as inflation and monetary tightening also weigh on the consumer - asking the question “where is the growth coming from, how does the UK solve the productivity puzzle? A higher UK growth trajectory is not only needed to recover from the faltering output gap at the hands of the pandemic and its fall-out but also to make the Chancellors figures work”. However, we also argued that while the UK growth dynamic is concerning in both the short and medium term, the underlying trajectory of GBP was likely to be driven in the near term by global factors, and (consistent with our commentaries over recent weeks) that it may be the USD that is on the back foot.
This week, with the Thanksgiving bank holidays in the US (and Japan), there is perhaps time for reflection on these global factors, but before we drift off too far into contemplation, the minutes from the November 1st/2nd FOMC meeting give us plenty to reflect upon. We have some thoughts.
It is important to first put the release of the Minutes (and the market reaction to the Minutes) into the context of the market reaction to the release of the Statement and subsequently to the Chair of the Fed Press Conference in early November. The Statement was more balanced and introduced the term “sufficiently restrictive” as we discussed at the time (Are The Balance of Risks Starting to Change for Rates, Risk and the USD?) and also emphasised that “the committee will take into account the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity (growth) and inflation…”. The market knee-jerk response to the Statement was risk positive/USD negative BUT then came the press conference. Essentially, in response to a potentially misleading question about market response to the FOMC, the Fed’s Chair gave a substantial list of reasons why the Fed would continue to err on the hawkish side. Risk assets sold off and US yields and the USD rose - in fact markets (and subsequently many commentators) factored in a further 25bps of rate hikes from the Fed. We were sceptical at the time. We remain so.
The headline grabbing sentence from the Minutes was “ a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate.” and as Fed whisperer Nick Timiraos pointed out only “a few other participants noted that, before slowing the policy rate increases it could be advantageous to wait until the stance of policy was more clearly in restrictive territory” - Markets now price only fractionally above 50bps for December.
However, we think that there are other details of the minutes that are more significant.
Firstly, on inflation, the Fed staff continued to view the risks to the inflation projection as skewed to the upside with inflation remaining stubbornly high. However, the meeting was before the release of the lower-than-expected October CPI print (released 10th November) and other more encouraging signs (from US PPI to global supply chain, commodity and perhaps even geopolitical improvements). Indeed “some noted that lower commodity prices or the expected reduced pressure on goods prices due to an easing of supply constraints should contribute to lower inflation in the medium term.” even prior to the recent developments.
However, it is the inference for growth that is potentially the most consequential.
“The projection for U.S. economic activity prepared by the staff for the November FOMC meeting was weaker than the September forecast… Sluggish growth in real private domestic spending, a deteriorating global outlook, and tightening financial conditions were all seen as salient downside risks to the projection for real activity; in addition, the possibility that a persistent reduction in inflation could require a greater-than-assumed amount of tightening in financial conditions was seen as another downside risk. The staff, therefore, continued to judge that the risks to the baseline projection for real activity were skewed to the downside and viewed the possibility that the economy would enter a recession sometime over the next year as almost as likely as the baseline.”
Last week, we stated our view that it is not clear that Central Banks should intentionally force demand destruction (through restrictive monetary policy) to counter temporary, supply driven inflation. Adding that, as demand peaks we would suggest that the urgency of Central Banks to act is likely to change significantly as the second derivative of inflation changes.
Growth is key in this respect. Indeed, the Minutes highlighted that “some participants observed that there had been an increase in the risk that the cumulative policy restraint would exceed what was required to bring inflation back to 2 percent”. In other words that the long and variable lags of monetary policy mean that the current settings may prove beyond “sufficiently restrictive”. If the balance of risks tips further towards recession AND the second derivative of inflation is still negative, it is not clear that the Fed - unique in their dual mandate: price stability AND maximum employment - will fulfil the rate hike expectations currently reflected in the Fed Funds Curve, let alone the recently upwardly revised terminal rates from a swathe of sell side analysts.
Thanksgiving may well therefore be an important period of reflection. Reflection on the comparable Black Friday and Cyber Monday retail sales volumes (values?). But for us there is a growing competitor in the US for the crown of most important macro variable - Inflation is being challenged by growth. Perhaps finally something else matters?
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The Fed Minutes, 1st/2nd FOMC Meeting - https://www.federalreserve.gov/monetarypolicy/fomcpresconf20221102.htm
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